Income Elasticity of Demand Versus Income Elasticity of Consumption

Abstract

The income elasticity of consumption depends not only on the demand function but also on the characteristics of the supply function. If supply is not completely elastic, the income elasticity of consumption will be less than the income elasticity of demand, with the difference depending on the shapes of both the demand and supply functions. We show if supply is sufficiently inelastic, extending the individual level estimates of the income elasticity of demand to aggregate values can produce erroneous and misleading policy conclusions. We suggest that the economics teaching and analysis carefully distinguish between the income elasticity of consumption for a good in a specific market (the observable quantity) and the income elasticity of demand (an unobservable function).